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TMI Blog2016 (5) TMI 728X X X X Extracts X X X X X X X X Extracts X X X X ..... Clause 5.5 of the agreement referred to by the AO indicates that the Assessee is authorized to audit the Indian subsidiary (Adobe India), so as to ensure that Adobe India adheres to the standards required by the Assessee. AO's view that Adobe India constitutes the Assessee's PE under Article 5(5) of the Indo-US DTAA is also wholly unsustainable. Article 5(5) of the Indo-US DTAA provides for an exclusion to Article 5(4) of the Indo-US DTAA. In terms of Article 5(4), where a person acts in a contracting state on behalf of an enterprise of the other contracting state, the enterprise shall be deemed to have a Permanent Establishment in the first mentioned state. In other words, a dependent agent of an enterprise would constitute its PE. In the present case, there is no material to form a view that Adobe India acts as an agent for and on behalf of the Assessee. Further, there is no allegation that any of the other conditions specified under clauses (a), (b) or (c) of paragraph 4 of Article 5 of the Indo-US DTAA are applicable to Adobe India. One of the necessary conditions for holding that an agent constitutes a PE of an enterprise is that the agent must have an authority to conclude ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ny/adjustment. 2.1 The Assessee disputes that it has a PE in India. It further contends that since the income of Adobe India has been assessed at Arm's Length Prices (ALP), no part of Assessee's income could be attributed to Adobe India even if it was assumed to be the Assessee's PE in India. On the other hand, it is the Revenue's case that the activities carried out by the Adobe India are the core business activities of the Assessee; Adobe India is the Assessee's PE in India; the cost plus basis on which Adobe India is remunerated by the Assessee does not capture the fair share of Assessee's income attributable to its PE; and that a part of the Assessee's income, computed on profit split method, is chargeable to tax under the Act. 2.2 Whilst the Assessee claims that there is no tangible material for the AO to have any reason to believe that the Assessee's income has escaped assessment, the Revenue contends that the transfer pricing report as submitted by Adobe India provides sufficient reason to form a belief that the Assessee's income had escaped assessment. Factual Background 3. The Assessee is a company incorporated un ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... the Tribunal's order in this Court which as yet is pending. The Assessee further informs that for AY 2007-08, the Transfer Pricing Study furnished by Adobe India was not accepted by the TPO, who sought to apply Profit Split Method (PSM) for determining the ALP instead of Transactional Net Marginal Method (TNMM) used in the preceding years. Adobe India successfully challenged the TPO's order for AY 2007-08 before the Dispute Resolution Panel (DRP) and the DRP has held that ALP be determined by applying TNMM as in the preceding years. 6. The AO issued the impugned notices under Section 148 of the Act on 30th March, 2011. In response to the aforesaid notice for AY 2004-05, the Assessee sent a letter dated 9th May, 2011 stating that it did not conduct any business activity in India and had not earned any taxable income except the interest on advances received from Adobe India, tax on which was duly withheld and deposited by Adobe India. The Assessee also referred to Section 115A (5) of the Act to contend that by virtue of the said provision, it was not liable to file its return of income under Section 139(1) of the Act, for the relevant year. The Assessee also sough ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... (b) the ownership of the software developed by Adobe India is the sole property of the Assessee and Adobe India does not retain any intellectual property rights in respect of the software developed by it; (c) the Assessee makes substantial profits by selling the software developed in India abroad for which no taxes have been paid by the Assessee in India; (d) Adobe India has been working wholly and exclusively for the Assessee and does not develop software for any other concern; and (e) the Assessee's transaction with Adobe India are not isolated transactions but a continuous business connection as Adobe India is connected to the Assessee through a network of lease lines and other technological means . 13. On the basis of the above, the AO concluded that activities carried out by Adobe India were a part of the Assessee s core business activities and, consequently, Adobe India constituted the Assessee's PE under Article 5(1) of the Indo-US Double Taxation Avoidance Agreement (DTAA). He also observed that in terms of the agreement between Adobe India and the Assessee, the Assessee was obliged to provide assistance, specifications and supervision ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... has escape assessment as per section 151 r.w.s. 148 of the Income-tax Act, 1961. The taxable profits for AYs 2004-05 and 2005-06 were also computed in a similar manner. Reasoning and Conclusion 16. It is apparent from the plain reading of the reasons recorded by the AO that his belief that the income of the Assessee had escaped assessment stems from his understanding that the activities pertaining to R D services rendered by Adobe India were conducted by the Assessee. He has, therefore, concluded that the Assessee must surrender a part of his income, which is attributable to those activities in India, to tax under the Act. It is not disputed that Adobe India has been assessed to tax on the very same activities priced on Arm's Length basis. In the circumstances, the first and foremost question to be considered is whether such activities of a subsidiary company could by itself provide a reason to believe that any income relating thereto has escaped assessment in the hands of foreign holding company. 17. Chapter X of the Act contains special provisions relating to avoidance of tax. Section 92 of the Act, which falls under Chapter X of the Act, mandates ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... And even if there is any dispute relating to the same, it is liable to be resolved in proceedings relating to Adobe India. 20. We may now refer to the provisions of Article 7 of the Indo-US DTAA which read as under:- ARTICLE 7 BUSINESS PROFITS 1. The profits of an enterprise of a Contracting State shall be taxable only in that State unless the enterprise carries on business in the other Contracting State through a permanent establishment situated therein. If the enterprise carries on business as aforesaid, the profits of the enterprise may be taxed in the other State but only so much of them as is attributable to (a) that permanent establishment ; (b) sales in the other State of goods or merchandise of the same or similar kind as those sold through that permanent establishment ; or (c) other business activities carried on in the other State of the same or similar kind as those effected through that permanent establishment. 2. Subject to the provisions of paragraph 3, where an enterprise of a Contracting State carries on business in the other Contracting State through a permanent establishment situated therein, there shall in each Contracting State ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... return for the use of patents, know-how or other rights, or by way of commission or other charges for specific services performed or for management, or, except in the case of a banking enterprise, by way of interest on moneys lent to the head office of the enterprise or any of its other offices. 4. No profits shall be attributed to a permanent establishment by reason of the mere purchase by that permanent establishment of goods or merchandise for the enterprise. 5. For the purposes of this Convention, the profits to be attributed to the permanent establishment as provided in paragraph 1(a) of this Article shall include only the profits derived from the assets and activities of the permanent establishment and shall be determined by the same method year by year unless there is good and sufficient reason to the contrary. 6. Where profits include items of income which are dealt with separately in other Articles of the Convention, then the provisions of those Articles shall not be affected by the provisions of this Article. 7. For the purposes of the Convention, the term business profits means income derived from any trade or business including income from the fur ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... s income had escaped assessment under the Act. 24. In the case of DIT (International Taxation) v. Morgan Stanley Company Inc.: (2007) 292 ITR 416 (SC), the Supreme Court had explained the above in the following manner:- 32. The object behind enactment of transfer pricing regulations is to prevent shifting of profits outside India. Under Article 7(2) not all profits of MSCO would be taxable in India but only those which have economic nexus with PE in India. A foreign enterprise is liable to be taxed in India on so much of its business profit as is attributable to the PE in India. The quantum of taxable income is to be determined in accordance with the provisions of I.T. Act. All provisions of I.T. Act are applicable, including provisions relating to depreciation, investment losses, deductible expenses, carry forward and set-off losses etc. However, deviations are made by DTAA in cases of royalty, interest etc. Such deviations are also made under the I.T. Act (for example: Sections 44BB, 44BBA etc.). Under the impugned ruling delivered by the AAR, remuneration to MSAS was justified by a transfer pricing analysis and, therefore, no further income could be attributed ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... O's opinion that the Assessee has a PE in India is informed by reason. 28. A subsidiary company is an independent tax entity and is separately taxed for its income in the country of its domicile. In the present case, Adobe India is a separate assessee and is liable to pay tax on its income. The fact that a holding company in another contracting state exercises certain control and management over a subsidiary would not render the subsidiary as a PE of the holding company. This is expressly spelt out in paragraph 6 of Article 5 of the Indo-US DTAA, which reads as under:- (6) The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of the other Contracting State, or which carries on business in that other State (whether through a permanent establishment or otherwise), shall not of itself constitute either company a permanent establishment of the other. 29. The aforesaid principle is also stated in Klaus Vogel on Double Taxation Conventions, Third Edition in the following words:- 40. [Principle] It is generally accepted that the existence of a subsidiary company does not, of itself, const ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... ABLISHMENT 1. For the purposes of this Convention, the term permanent establishment means a fixed place of business through which the business of an enterprise is wholly or partly carried on. 2. The term permanent establishment includes especially: a) a place of management; b) a branch; c) an office; d) a factory ; e) a workshop ; f) a mine, an oil or gas well, a quarry, or any other place of extraction of natural resources ; g) a warehouse, in relation to a person providing storage facilities for others ; h) a farm, plantation or other place where agriculture, forestry, plantation or related activities are carried on; i) a store or premises used as a sales outlet; j) an installation or structure used for the exploration or exploitation of natural resources, but only if so used for a period of more than 120 days in any twelve-month period ; k) a building site or construction, installation or assembly project or supervisory activities in connection therewith, where such site, project or activities (together with other such sites, projects or activities, if any) continue for a period of more ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... rst-mentioned State a stock of goods or merchandise from which he regularly delivers goods or merchandise on behalf of the enterprise, and some additional activities conducted in the State on behalf of the enterprise have contributed to the sale of the goods or merchandise ; or c) he habitually secures orders in the firstmentioned State, wholly or almost wholly for the enterprise. 5. An enterprise of a Contracting State shall not be deemed to have a permanent establishment in the other Contracting State merely because it carries on business in that other State through a broker, general commission agent, or any other agent of an independent status, provided that such persons are acting in the ordinary course of their business. However, when the activities of such an agent are devoted wholly or almost wholly on behalf of that enterprise and the transactions between the agent and the enterprise are not made under arm's length conditions, he shall not be considered an agent of independent status within the meaning of this paragraph. 6. The fact that a company which is a resident of a Contracting State controls or is controlled by a company which is a resident of t ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... US DTAA. The Court had further expressly held that : Even if the foreign entities have saved and reduced their expenditure by transferring business or back office operations to the Indian subsidiary, it would not by itself create a fixed place or location permanent establishment. The manner and mode of the payment of royalty or associated transactions is not a test which can be applied to determine, whether fixed place permanent establishment exists. Reference to core of auxiliary or preliminary activity is relevant when we apply paragraph 3 of Article 5 or when sub-clause (a) to paragraph 4 to Article 5 is under consideration. The fact that the subsidiary company was carrying on core activities as performed by the foreign assessee does not create a fixed place permanent establishment. 34. Thus, the AO's view that Adobe India constituted the Assessee's PE in terms of paragraph 1 of Article 5 of the Indo-US DTAA is palpably erroneous and not sustainable on the basis of the facts as recorded by him. 35. We also find that there is no material to hold that the Assessee's employees constitute a Service PE in terms of Article 5(2)(l) of the Indo- U ..... X X X X Extracts X X X X X X X X Extracts X X X X ..... no material to form a view that Adobe India acts as an agent for and on behalf of the Assessee. Further, there is no allegation that any of the other conditions specified under clauses (a), (b) or (c) of paragraph 4 of Article 5 of the Indo-US DTAA are applicable to Adobe India. One of the necessary conditions for holding that an agent constitutes a PE of an enterprise is that the agent must have an authority to conclude contracts or should have been found to be habitually entering into or concluding contracts on behalf of the enterprise. In the present case, there is no allegation that Adobe India is authorised to conclude contracts on behalf of the Assessee or has been habitually doing so. 38. Insofar as Article 5(5) of the Indo-US DTAA is concerned, the same postulates that any business carried through a broker, commission agent or any other agent of an independent status acting in its normal course would not constitute a PE of an enterprise. The exception to this being that if activities of such agent are devoted wholly or almost wholly on behalf of the enterprise and the transactions between enterprise and the agent are not made under arm's length conditions. In such ..... X X X X Extracts X X X X X X X X Extracts X X X X
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